Dissecting Durable Goods Data

It's always important to look at the details in economic data reports. For example, the headline for this morning's Durable Goods report indicated a plunge in new orders of 5.2%. That may sound bad, but bear in mind that this decrease followed a 3.7% December increase – and three previous consecutive monthly increases.

The rest of the report contains a few key takeaways. The first is that the weakness was concentrated in two limited areas. Nondefense aircraft orders, an often volatile segment, fell by 34%. When you exclude transportation, new orders actually rose by 1.9%, following gains in prior months.

Then there is defense. Spending in this category fell by 69.5% as future reductions in troops abroad plus the impending sequester led to fewer new orders being placed. How this will ripple through the rest of the economy? Bear in mind that, in the fourth quarter, cutbacks in defense spending fell by 22.4%, subtracting 1.28 percentage points from fourth-quarter GDP. However, outside of the big drop in defense spending in today's report, orders fell by -0.4%, reflecting the aforementioned drop in aircraft orders.

Looking at the category of business investment that excludes both defense and aircraft, orders surged by 6.3%. That means that businesses may likely be more confident that economic conditions might improve, now that we have part of the fiscal cliff debate behind us. (I say "part" because we still have the sequester, which, beginning March 1, will cut federal spending by $85 billion for the remainder of the year.)

Even so, businesses may be planning on stronger growth ahead, particularly given that machinery orders posted a robust 13.5% gain. Other categories weren't as strong this month, including new orders for computers and electronic products, which fell by 5.3%. However, this followed gains in previous months. Motor vehicle new orders were flat, but then again, automakers in the past three months reported the biggest three-month level of sales in five years and some giveback is plausible.

Let's zero in on machinery, with special attention to what that means for businesses' views of the future. Perhaps it means that companies might want to replace people with robots. But it's more likely that this reflects that manufacturers are anticipating better times ahead (outside defense contractors, of course). Machinery is used to make other things, and more new orders here can portend a more positive outlook.

In that regard, listen to what manufacturers are saying about their outlook, instead of looking at their current production. In the New York Fed's Empire State Manufacturing Survey, which includes many tech firms, we see that the general business conditions index rose into positive territory for the first time since July 2012, climbing 18 points to 10. Also, 29% of respondents reported that conditions had improved over the month, while 19% -- a signiﬁcantly lower percentage than in the January survey -- reported that conditions had worsened. The new orders index also rose sharply, climbing 20 points to 13.3, its highest level since mid-2011. Indices for the six-month outlook were noticeably higher this month. The future business conditions index rose 11 points to 33.1, which marks its highest level in several months.

The Philadelphia Fed's Business Outlook Survey, which includes many automotive and heavy industry firms, printed a negative reading for the headline, but the survey's future indicators suggest that firms expect recent declines to be temporary. The future general activity index increased from a reading of 29.2 to 32.1, its third consecutive monthly increase. The percentage expecting increases in activity over the next six months (47%) exceeded the percentage expecting decreases (15%).

So, aside from defense contractors, other manufacturers aren't seeing pessimism, even with the sequester looming. Of course, some businesses may have based their more optimistic future assessments on a budget deal having been passed by now. But judging from the market's sanguine response to the news that Friday's deadline will unlikely be met with a resolution, maybe businesses don't think a sequester is quite the end of the world that some have portrayed it to be.